Questions Presented:

1. May an insurer double the premium on a
commercial general liability policy, businessowners policy, or workers compensation
policy because the insured has not permitted the insurer to audit the insureds books
and records?

2. May an insurer cancel a commercial
general liability policy, businessowners policy, or workers compensation policy
mid-term because the insured has not permitted the insurer to audit the insureds
books and records?

3. May an insurer cancel a workers
compensation policy mid-term because the insured has not permitted the insurer to audit
the insureds books and records?

Conclusions:

1. No. N.Y. Comp. Codes R. & Regs. tit.
11, § 161.10(c) (1996) specifically states that if an insured fails to cooperate with the
insurer in its attempt to conduct an audit of a policy subject to audit to determine a
proper premium, then the insurer shall nonrenew such insured upon completion of the
current policy period in accordance with N.Y. Ins. Law § 3426, due to an inability to
establish a proper premium for such insured. Doubling the policy premium without an
underwriting basis approved by the insurance department would constitute an impermissible
deviation from the rate filing.

2. N.Y. Comp. Codes R. & Regs. tit. 11,
§ 161.10(c) (1996) specifically states that if an insured fails to cooperate with the
insurer in its attempt to conduct an audit of a policy subject to audit to determine a
proper premium, then the insurer shall nonrenew such insured upon completion of the
current policy period in accordance with N.Y. Ins. Law § 3426, due to an inability to
establish a proper premium for such insured.

3. Yes, subject to the terms of the actual
policy, workers compensation insurance policies are exempted by N.Y. Ins. Law §
3426(l)(2) from the limitations on cancellation imposed by N.Y. Ins. Law § 3426(e) for
other commercial insurance policies. N.Y. Workers Comp. Law § 54 permits
cancellation upon 30 days notice.

Facts:

The insurer uses audits on three types of
policies to determine exposure base for premium: workers compensation,
businessowner, and commercial general liability. The exposure base is either sales or
payroll, depending on classification. The insurer begins its audit after the conclusion of
the policy year.

For those insureds who do not cooperate
with an audit, the insurer would like to double the exposure base and change the current
term premium to a premium based upon the doubled exposure base.

Analysis:

N.Y. Ins. Law § 2314 (McKinneys
2000) states:

No authorized insurer shall, and no
licensed insurance agent, no employee or other representative of an authorized insurer,
and no licensed broker shall knowingly, charge or demand a rate or receive a premium which
departs from the rates, rating plans, classifications, schedules, rules and standards in
effect on behalf of the insurer, or shall issue or make any policy or contract involving a
violation thereof.

Generally, this section prohibits an
insurer from departing from its rate filings. An insurer may not double a policy premium
because of an insureds failure to respond to the insurers request for a
premium audit of without a sound underwriting basis approved by the insurance department
in the insurers rate filing. This would constitute an impermissible deviation from
the rate filing.

N.Y. Comp. Codes R. & Regs. tit. 11, §
161.10 (1996) states:

(a) An audit to determine final premium for
policies under which the initial premium is based on an estimate of the insured's exposure
base shall be conducted within 180 days after expiration of such policy, and may not be
waived except in the following circumstances:

(1) the total annual premium attributable
to the auditable exposure base is not reasonably expected to exceed $1,500;

(2) the policy requires notification to the
insurer with the specific identification of any additional exposure units for which
coverage is requested (i.e., motor vehicles); or

(3) the policy is a commercial umbrella for
which the rate or premium is determined by the application of a factor to the rate or
premium of an auditable underlying policy.

(b) The insurer shall, as soon as
practicable following such audit, refund or credit the insured's account for any return
premium due the insured, or bill and make a good faith effort to collect any additional
premium due the company, as a result of the audit.

(c) If an insured fails to cooperate with
the insurer in its attempt to conduct such audit, including failure to return any
questionnaires or self-audit worksheets, the insurer shall nonrenew such insured upon
completion of the current policy period, in accordance with the provisions of section 3426 of the Insurance Law, due to the insurer's
inability to establish a proper premium for such insured.

With respect to a commercial general
liability policy and a businessowners policy, N.Y. Comp. Codes R. & Regs. tit. 11, §
161.10 (1996) addresses situations pertaining to policies subject to audit and
specifically directs insurers to nonrenew an insured upon the completion of the current
policy period in accordance with N.Y. Ins. Law 3426, in the event that the insured fails
to respond to the insurers attempt to audit the insured, due to the insurers
inability to establish a proper premium.

One of the primary policy purposes of this
regulation was to stabilize the market by preventing large price swings while promoting
competition with a flexible rating system. To achieve this goal, the regulation requires
cooperation from the insured with premium audits. However, the regulation directs a
specific action by the insurer and does not permit an insurer to double premiums or to
cancel a policy mid-term.

The insurer asks whether the failure to
cooperate with a premium audit qualifies as grounds for mid-term cancellation pursuant to
N.Y. Ins. Law § 3426(c)(1)(D), on the basis that the failure to cooperate with the
premium audit after renewal constitutes and act or omission, or violation of a policy
condition, that substantially and materially increases the hazard insured against, and
which occurs subsequent to the inception of the current policy period. The insurer also
would like to know whether the failure to cooperate with a premium audit, after renewal,
constitutes a material change in the nature of the risk which causes the risk of loss to
be substantially and materially increased beyond that contemplated at the time the policy
was renewed which would permit mid-term cancellation under N.Y. Ins. Law § 3426(c)(1)(E)

(c) After a covered policy has been in
effect for sixty days unless cancelled pursuant to subsection (b) of this section, or on
or after the effective date if such policy is a renewal, no notice of cancellation shall
become effective until fifteen days after written notice is mailed or delivered to the
first-named insured and to such insured's authorized agent or broker, and such
cancellation is based on one or more of the following:

(1) With respect to covered policies:

* * *

(D) after issuance of the policy or after
the last renewal date, discovery of an act or omission, or a violation of any policy
condition, that substantially and materially increases the hazard insured against, and
which occurred subsequent to inception of the current policy period;

(E) material physical change in the
property insured, occurring after issuance or last annual renewal anniversary date of the
policy, which results in the property becoming uninsurable in accordance with the
insurer's objective, uniformly applied underwriting standards in effect at the time the
policy was issued or last renewed; or material change in the nature or extent of the risk,
occurring after issuance or last annual renewal anniversary date of the policy, which
causes the risk of loss to be substantially and materially increased beyond that
contemplated at the time the policy was issued or last renewed;

There is no basis in the hypothetical facts
presented that would suggest that failure of the insured to cooperate with a premium audit
would constitute an act or omission, or a violation of a policy condition, that
substantially and materially increases the hazard insured against under N.Y. Ins. Law §
3426(c)(1)(D). There is also no basis in the hypothetical facts presented that would
suggest that failure of the insured to cooperate with a premium audit would constitute a
material change in the nature or extent of the risk which causes the risk of loss to be
substantially and materially increased beyond that contemplated at the time the policy was
renewed that would permit mid-term cancellation under N.Y. Ins. Law § 3426(c)(1)(E).

Since workers compensation policies
are exempted by N.Y. Ins. Law § 3426(l)(2) from the limitations on cancellation imposed
by N.Y. Ins. Law § 3426(e) for other commercial insurance policies, the preceding
analysis regarding mid-term cancellation does not apply to workers compensation
policies.

Cancellation of a workers
compensation policy in is governed by N.Y. Workers Comp. Law § 54(5) (West, WESTLAW
through 1993 legislation).

1. Cancellation and termination of
insurance contracts. No contract of insurance issued by an insurance carrier against
liability arising under this chapter shall be cancelled within the time limited in such
contract for its expiration unless notice is given as required by this section. When
cancellation is due to non-payment of premiums such cancellation shall not be effective
until at least ten days after a notice of cancellation of such contract, on a date
specified in such notice, shall be filed in the office of the chair and also served on the
employer. When cancellation is due to any reason other than non-payment of premiums such
cancellation shall not be effective until at least thirty days after a notice of
cancellation of such contract, on a date specified in such notice, shall be filed in the
office of the chair and also served on the employer; provided, however, in either case,
that if the employer has secured insurance with another insurance carrier which becomes
effective prior to the expiration of the time stated in such notice, the cancellation
shall be effective as of the date of such other coverage. No insurer shall refuse to renew
any policy insuring against liability arising under this chapter unless at least thirty
days prior to its expiration notice of intention not to renew has been filed in the office
of the chair and also served on the employer.

2. Such notice shall be served on the
employer by delivering it to him, her or it or by sending it by mail, by certified or
registered letter, return receipt requested, addressed to the employer at his, her or its
last known place of business; provided that, if the employer be a partnership, then such
notice may be so given to any of one of the partners, and if the employer be a corporation
then the notice may be given to any agent or officer of the corporation upon whom legal
process may be served; and further provided that an employer may designate any person or
entity at any address to receive such notice including the designation of one person or
entity to receive notice on behalf of multiple entities insured under one insurance policy
and that service of notice at the address so designated upon the person or entity so
designated by delivery or by mail, by certified or registered letter, return receipt
requested, shall satisfy the notice requirement of this section.

Subject to the terms of the actual policy,
N.Y. Workers Comp. Law § 54 permits mid-term cancellation of workers
compensation policies with 30 days notice provided that the insurer complies with the
extensively detailed notice procedures required by the statute.

For further information you may contact
Special Counsel Athan Shinas at the Albany Office.